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Mutual Fund Attributes and Investor Behavior

Nicolas P. B. Bollen*

1 study the dynamics of itivestor cash flows in socially responsible mutual funds. Consistent
with anecdotal evidence of loyally, the monthly volatility of investor cash fiows is lower
in socially responsible funds than in conventional funds. I find strong evidence that cash
flows into socially responsible funds are more sensitive to lagged positive retums than
cash flows into conventional funds, and weaker evidence that cash outflows from socially
responsible fund.s are less sensitive to lagged negative retums. These results indicate that
investors derive utility from the socially responsible attribute, especially when retums are

I. Introduction
Mutual futid companies continually introduce new types of funds in an effort
to attract investor capital and maximize assets under management. The decision
to introduce a new type of fund is affected by a number of variables, including
investor demand for the fund's attributes. As argued by Kborana and Servaes
(1999), new fund types in higb demand generate capital inflows and incremental
revenue for tbe fund company. Subsequent investor bebavior, bowever, may affect
tbe operating costs and viability of the new funds. If a new fund type draws my-
opic investors, for example, tben shareholder subscription and redemption activity
may be more volatile and difficult to manage. In this paper, 1 study a specific fund
type—socially responsible (SR) equity mutual funds—in order to explore investor
decision making in new funds.
According to the Social Investment Forum (SIF) (2001), assets invested in
all socially screened portfolios exceeded $2 trillion in 2001 witb $136 billion
invested in mutual funds, reflecting increased awareness of social responsibility
and corporate ethics in the investment community. SR investing integrates per-
sonal values and societal concerns witb tbe investment decision via shareholder
• Bollen,, Vanderbiit University, Owen Graduate School of Man-
agement, 401 2ist Avenue Soulb. Nashville, TN 37240. I tbank Cliff Ball. Roben Bauer Uhe referee).
Stephen Brown (the editor), Jelf Busse, LuboS P:Sstor, Jim Smilh, and seminar participants at Duke
University, the University of Oklahoma. Vanderbiit University, and the 2(X)5 EFA and 2(X)5 FMA
annual meetings lor helpful comments. Mark Cohen deserves special praise for his assistance with
this project. I gratefully acknowledge generous research support from the Dean's Fund for Research
and the Financial Markets Research Center al the Owen Graduate School of Management, Vanderbiit
University. ,
684 Journal of Financial and Quantitative Analysis

activism, community investment, and, most visibly, investing witb social screens.
Social screens often exclude securities of companies In particular industries, as
well as subjecting companies to qualitative criteria involving social or environ-
mental causes. To illustrate, consider tbe Dotnini Social Index, which was created
in 1990 by Kinder, Lydenberg, Domini & Company, and wbicb incorporates botb
exclusionary and qualitative screens. As described by Statman (2000), securities
of companies that derive 2% or more of sales from military weapons systems, de-
rive any revenues from the manufacture of alcohol or tobacco products, or derive
any revenues from tbe provision of gambling products or services are not eligible
for inclusion in the index. Qualitative screens inciude a company's record on di-
versity, employee relations, and the environment. CSX Corporation, for example,
was dropped from the index in 1998 for a poor environmental and safety record,
whereas Compuware Corporation was added in 1999 for success with a diversity
program and employee relations.
Research regarding SR investing has to date focused exclusively on whether
there is a difference between the performance of socially screened portfolios and
tbat of conventional funds. In the spirit of Markowitz (1952), social screens may
constrain portfolio optimization. A natural questioti to address is wbetber these
constraints are binding on perfonnance, that is, whether the risk-adjusted retums
of socially screened investment vehicles are inferior to tbose of conventional in-
vestments. Alternatively, social screens might serve as filters for management
quality and hence generate superior risk-adjusted retums. Derwall, Guenster,
Bauer, and Koedijk (2005), for example, find tbat companies rated bighly for en-
vironmental performance outperfonn those rated poorly. Otber studies of SR in-
vesting, including Hamilton, Jo, and Statman (1993), Statman (2000), and Bauer,
Koedijk, and Otten (2005), compare tbe risk-adjusted returns of SR mutual funds
to tbe risk-adjusted retums of matched conventional funds and find that SR mu-
tual funds perform no differently than conventional funds. Bauer et al. point out
tbat in the early part of tbeir sample, from 1990 to 1993, SR mutual funds under-
performed their conventional counterparts, perhaps indicating a learning phase.
Geczy. Stambaugh, and Levin (2003) use a different approach to measuring per-
formance: the Bayesian framework of Pdstor and Stambaugh (2002). Under the
assumption that investors possess a diffuse prior belief about managerial ability
and use tbe Capital Asset Pricing Model (CAPM) to select funds, Geczy et al.
also find the performance of SR and conventional funds to be comparable. The
general conclusion one can draw from existing studies is that SR mutual fund per-
formance is not significantly different from the perfonnance of funds that do not
screen on social criteria.
Another important question—and one that bas not yet been addressed by
the literature—is whether the bebavior of investors in SR mutual funds differs
from the behavior of investors in conventional funds. Studying the behavior of
SR investors is important from an industry perspective: cash flows into and out
of mutual funds from shareholder subscriptions and redemptions can pose a sub-
stantial burden on fund managers, as well as passive mutual fund shareholders.
For tbis reason, identifying sources of stable investment should be of practical
interest to mutual fund companies. Studying SR investors is also important from
an academic perspective: the SR attribute provides a natural bebavioral experi-
Bollen 685

ment. Geczy et al. (2003) report anecdotal evidence that SR investors withdrew
capital at a slower rate than investors in conventional funds during the 1999 to
2001 period, suggesting that SR investors are more loyal. In this paper, I study
the bebavior of SR investors more comprehensively, controlling for other factors
tbat might explain differences across SR and conventional funds.
On tbe one hand, investors in SR funds may have decided to invest as part of
a standard risk-reward optimization. If so, then traditional asset pricing models
should adequately describe the decision to initially invest in the fund, and suhse-
quent decisions to change allocation to the fund. On tbe other hand, investors in
SR funds may derive utility from owning the securities of companies that are con-
sistent with a set of personal values or societal concems. In other words, they may
have a multi-attribute utility function—one that incorporates an additional aspect
of their investment choice. These investors may view investing in an SR fund
as consuming the SR attribute. In order to smooth consumption of the attribute,
subscription and redemption activity may be more regular in SR funds tban in
conventional funds. I use the net of aggregate investor subscriptions and redemp-
tions, or fund tlow, to measure sbarebolder activity. Consistent with the intuition
tbat tbe SR attribute smoothes allocation decisions, I find that over tbe 1991 to
2002 period, the monthly volatility of fund flow in SR funds is significantly lower
than conventional fund fiow volatility.
Studying the relation between fund flow and fund performance provides ad-
ditional insight. I present several competing hypotheses regarding the manner in
which the SR attribute affects investor decision making, each of which makes an
empirical prediction for tbe flow-performance relation. I find that the sensitivity
of fund fiow to lagged positive retums is higher in SR funds than in conventional
funds. This result is consistent with both a model of rational learning, in which
SR investors have more diffuse prior beliefs about tbe SR strategy, as well as a
conditional utility function in wbich SR investors derive utility from consuming
the SR attribute if tbe investment is warranted on its financial merits alone. To dis-
tinguisb between the two, I measure tbe flow-performance and fund flow volatility
separately for subsets of tbe sample based on fund age. If SR investor bebavior
is govemed by a conditional utility function, then differences between SR funds
and conventional funds should persist. If SR investor behavior is instead gov-
emed by rational leaming, tben differences between SR funds and conventional
funds should disappear over time as the precision of prior beliefs converges. I find
tbat tbe differences between SR and conventional funds are significant for young
and mature funds alike; bence, tbe conditional utility function appears to capture
behavior better than a model of rational learning.
I aiso find weaker evidence tbat tbe sensitivity of fund flow to lagged negative
retums is lower in SR funds than in conventional funds, indicating that the utility
derived from consuming the SR attribute may mitigate the tendency to shift capital
away from poorly performing SR funds. Lastly, I conduct several additional tests
to ensure the robustness of tbe paper's main results. Statistical significance is
maintained when standard errors are measured using a least absolute deviations
(LAD) approach, which minimizes the impact of outliers. Differences between
SR and conventional funds are qualitatively consistent wben measured separately
across two subperiods.
686 Journal of Financial and Quantitative Analysis

The rest of this paper is organized as follows. Section II presents competing

hypotheses for the bebavior of SR investors. Motivating assumptions are drawn
from existing literature. In Section III. I describe the data. Section IV presents
tbe empirical methods and results. Special attention is paid to tbe construction of
a control group. I summarize the findings in Section V.

II. Hypothesis Development

This section develops competing hypotheses for the behavior of investors in
SR funds. Subsections A and B review tbe mutual fund flow-performance relation
and fund flow volatility in a general setting to provide a context for tbe altemative
hypotheses. Subsection C lists tbe bypotheses, motivates tbem witb assumptions
supported by existing research, and discusses empirical predictions.

A. The Flow-Performance Relation

As argued by Jensen (1968), a corollary of the efficient market bypotbesis

is that average risk-adjusted mutual fund retums should reflect only the expenses
incurred in tbe course of managing the fund. Time-series variation in mutual fund
performance should be random; bence, investors should not be concemed with
past performance but rather with fund expenses as these are to some extent en-
dogenous. Prior studies of the flow-performance relation, however, report strong
evidence that a mutual fund's past performance influences subsequent subscrip-
tion and redemption activity. See, for example. Chevalier and Ellison (1997), Sirri
and Tufano (1998), Busse (2001), and De! Guercio and Tkac (2002). Tbe relation
is often found to be asymmetric, such that poor performers are not punished to
the same extent that strong performers are rewarded.
In the context of the efficient market hypothesis, the observed flow-perfor-
mance relation is a financial anomaly. One explanation for the flow-performance
anomaly is that investor actions may be driven at least in part by psychological
biases. These biases can be modeled as errors in the Bayesian updating performed
by investors wben making an investment decision. One example is tbe tendency
for people to simplify difficult problems by ignoring prior beliefs and acting ex-
clusively on recent observations. Kahneman and Tversky (1982) label this the
representative heuristic. The representative heuristic predicts that mutual fund
investors disregard prior beliefs regarding managerial ability and instead simply
subscribe to recent top performers and redeem from recent poor performers.
Brav and Heaton (2002) provide an altemative explanation for tbe flow-
performance anomaly. If a relevant feature of tbe economy is unobservable, e.g.,
managerial ability, then the anomaly can be explained by rational leaming. Empir-
ical research in tbe equities market bas reported a long list of anomalies tbat some
fund managers may be able to exploit on a consistent basis to generate superior
retums.' Ippolito (1992), Lyncb and Musto (2003), and Berk and Green (2004),
among otbers, interpret the flow-perfonnance relation as a reflection of investors
'For examples of stock market anomalies, see Basu (1977). Banz (1981), Keim (1983). Rein-
ganutn (1983), Blume and Stambaugh (1983). De Bond! and Thaler (1985), (1987). Jegadeesh and
Titman (1993), Fama and French (1992), and Lakonishok, Shleifer, and Vishny (1994).
Bollen 687

updating their beliefs about managerial ability and expected mutual fund retums.
1 focus on this rational learning explanation for the flow-performance relation be-
cause it does not depend on any assumptions about specific psychological biases
for which consensus has not been reached in the Uterature.

B. Fund Flow Volatility

Investors subscribe to and redeem from mutual funds for at least three rea-
sons. First, as described above, changes in expectations of mutual fund perfor-
mance may motivate investors to reallocate capital among their itivestments. Sec-
ond, since mutual funds can be traded daily, investors may move capital into and
out of tbem to address their liquidity needs. Third, Massa (2003) argues that in-
vestors may subscribe to or redeem from specific mutual funds in order to change
their consumption of or exposure to attributes otber than expected return and risk.
There are two benefits to using fund flow volatility as a measure of investor
behavior. Eirst, tbe volatility of monthly fund flows captures the net effect of
investors' decisions witbout forcing any stmcture on tbe decision making process.
This avoids problems associated witb misspecification, though it does not provide
much insight into how investors perceive their mutual fund investment. Second,
from a practical perspective, the primary concern of mutual fund companies is
likely to be the overall variability of investor casb flows, since this captures tbe
burden that active investors place on fund companies and passive shareholders
through trading.- Not surprisingly, many mutual fund companies have imposed
redemption fees to discourage investors from strategically exploiting the liquidity
provided to them.^

C. Alternative Hypotheses for SR Investor Behavior

I list below tbree testable hypotheses regarding tbe flow-performance rela-

tion and fund fiow volatility of SR funds relative to conventional funds.
Hypothesis 1. The flow-performance relation and futid flow volatility of SR funds
is equal to tbat of conventional funds.
The first hypothesis is motivated by the assumption that investor preferences
can be represented by a utility function defined over the moments of a portfolio's
retum distribution. This assumption is the basis of the standard finance paradigm
underlying, for example, the CAPM of Sharpe (1964), Lintner(l965), and Mossin
(1966) in which utility is a function solely of expected retum and variance. When
investors leam about expected return in a multi-period setting, tben tbe standard
finance paradigm can generate a mutual fund flow-pertormance relation and fund
flow volatility. Berk and Green (2004) present a model in which rational Bayesian
investors use past mutual fund performance to update beliefs about managerial
ability as manifested in expected retums. Tbey derive a positive relation between
-Edelen (1999) finds that liquidity-motivated trading reduces abnormal returns by over 1^ per
year in his sample of mutual funds.
•'See Goetzmann. Ivkovich, and Rouwenhorst (2001) and Boudoukh. Richardson. Subrahmanyam,
and Whitelaw (2002) for a description of how active investors can expropriate value from intemational
mutual funds. i
688 Journal of Financial and Quantitative Analysis

past performance and subsequent fund flow, resulting from a rational reallocation
of capital to better managers. Fund flow volatility increases in the sensitivity of
investors to past performance.
The first hypothesis implies that investors assess SR funds the same way that
they assess other funds as simply another candidate investment for the portfolio
optimization problem. If so. then after controlling for other relevant variables
such as fund age and fund size, the flow-performance sensitivity and fund flow
volatility of SR funds will equal that of conventional funds.
Hypothesis 2. The flow-performance relation of SR funds is stronger than that of
conventional funds.
The second hypothesis can also be motivated by the standard finance para-
digm with the additional assumption that prior beliefs regarding the expected re-
turn of SR funds are more diffuse than prior beliefs about conventional funds.
Chevalier and Ellison (1997) find that the flow-performance sensitivity of young
funds is stronger than that of mature funds, suggesting that beliefs about funds
with limited track records are more diffuse. The SR strategy is relatively new and
constitutes only a small fraction ofthe U.S. mutual fund industry as I show in the
next section; hence, it seems reasonable to assume investors are uncertain about
the performance of the SR strategy. Indeed, the existing SR literature focuses
exclusively on measuring the difference in performance between SR and conven-
tional strategies because it is an open question. Rational investors assessing an SR
fund, therefore, may have more diffuse prior beliefs about the effectiveness of the
SR investment strategy compared to priors for conventional funds, and may give
more weight to recent observations of SR fund performance than to recent obser-
vations of the performance of other funds. The assumptions of rational learning
and diffuse prior beliefs, then, predict that capital inflows and outflows are more
sensitive to performance in SR funds than in other funds.
Alternatively, the second hypothesis can be motivated by the assumption that
preferences of SR investors can be represented by a multi-attribute utility func-
tion defined over the moments of a portfolio's return distribution and a variable
representing whether the investment decision is SR. The assumption is consistent
with the joint goals of social responsibility and financial performance that fund
companies generally stress when advertising SR funds. To illustrate, consider this
excerpt from the Domini Social Investments Web site (
Our shareholders invest with us for a variety of reasons, ranging from
meeting important financial goals such as retirement or savings for col-
lege to building personal wealth, but one thing they all share in common
is an understanding of the importance of their investment decisions. At
Domini Social Investments, we are dedicated to making your invest-
ment decisions count—for your personal financial benefit, as well as
for your broader hopes for a healthier environment and a more just and
humane economy.

The assumption is also consistent with Statman (1999) who argues that, in con-
trast to the standard paradigm, behavioral finance views the investment decision
as a type of product choice, so that "value-expressive" characteristics of an as-
Bollen 689

set affect its desirability. Admittedly, there is no evidence in the existing finance
literature to suggest that investors pay attention to attributes unrelated to perfor-
mance. A survey of mutual fund investors in Capon, Fitzsimons, and Prince
(1996). for example, asks investors to reveal which criteria they use to select
funds. On a scale of I (not at all important) to 5 {extremely important). Invest-
ment Performance Track Record received a mean of 4.62, whereas Community
Service/Charity Record received a 1.09. My sample, though, represents a group
of investors v/ith a revealed preference for SR funds, and one purpose of this paper
is to determine whether the SR attribute by itself is important lor this group.
I assume that SR investors can derive additional utility from consuming the
SR attribute, but only if the SR investment would have been selected on its finan-
cial merits alone. I refer to this as a conditional utility function. The notion that
the investment decision is conditional on satisfactory levels of risk and expected
retum is consistent with laws governing the actions of fiduciaries in most states.
The Uniform Law Commissioners promulgated the Uniform Prudent Investor Act
(UPIA) in 1994, and it has since been adopted in 44 states.'* Section 2(b) states "a
trustee's investment and management decisions respecting individual assets must
be evaluated not in isolation but in the context of the trust portfolio as a whole
and as a part of an overall investment strategy having risk and retum objectives
reasonably suited to the trust." Thus, unless the terms of the tmst specify a pref-
erence for the SR attribute, a fiduciary cannot invest in an SR fund if it would
adversely affect financial performance.
If SR investor utility functions are conditional, then the flow-performance
relation in SR funds may be stronger than that of conventional funds. Positive
retums may attract larger inflows for SR funds than conventional funds, since
SR investors rationally revise upward their expectations of fund performance as
would investors in conventional funds, and additionally SR investors may increase
their investment in the SR fund to consume the SR attribute.
In order to differentiate between the two motivating assumptions for the sec-
ond hypothesis, note that they generate different predictions for fund flow volatil-
ity. If the assumption of rational leaming with diffuse prior beliefs is driving a
stronger flow-performance relation, then fund flow volatility would be higher in
SR funds than in conventional funds. The reason is that under this assumption, the
only difference between the two groups of funds is the flow-performance sensitiv-
ity. If the assumption of a conditional, multi-attribute utility function is driving a
stronger flow-performance relation, then fund flow volatility in SR funds may be
equal to or lower than the fund flow volatility of conventional funds. If investors
derive utility from consuming the SR attribute, then one might expect lower liq-
uidity trading if substitutes are available, thereby offsetting the higher volatility
resulting from the flow-performance sensitivity.
One can also distinguish between the two explanations for the second hy-
pothesis by measuring the difference between SR funds and conventional funds
as funds age. If SR investor behavior is govemed by preferences that are repre-
sented by a multi-attribute utility function, then differences between SR funds and
conventional funds should persist. If SR investor behavior is instead govemed by

690 Journal of Financial and Quantitative Analysis

rational leaming with diffuse priors, then differences between SR funds and con-
ventional funds should disappear over time as the precision of prior beliefs con-
verge. Following Chevalier and Ellison (1997), I examine the flow-performance
relation and fund flow volatility for subsets of my sample split by the age of the
fund. Young funds are defined as those aged five years or less, whereas mature
funds are those aged six years or more.
Hypothesis 3. The flow-performance relation of SR funds is weaker than that of
conventional funds, and the fund flow volatility of SR funds is lower than that of
conventional funds.
The third hypothesis can also be motivated two ways. The flrst motivation
is the assumption that preferences of SR investors can be represented by a multi-
attribute utility function defined over the moments of a portfolio's retum distribu-
tion and a variable representing whether the investment decision is SR as before,
except now the utility function is additive in the attributes. As defined by Keeney
and Raiffa (1993). an additive utility function is permitted when attributes are util-
ity independent, i.e., preferences for one attribute are unaffected by the level of the
other attribute. Additive utility functions are common in the product choice lit-
erature given their tractability. Massa (2003) and Horta^su and Syverson (2004),
for example, both assume an additive utility function in their analyses of product
choice in the mutual fund industry. The assumption of an additive utility function
implies that the utility derived from the SR attribute is separable from and substi-
tutable for the utility derived from an investment's risk and return. An important
caveat to the assumption of an additive utility function is that it is inconsi.stent
with the UPIA because it allows for a trade-off between performance and the SR
attribute. The assumption of an additive utility function, therefore, only is rele-
vant when investment decisions are made by investors on their own behalf, or in
the case of trusts with a specific SR mandate.
To derive an empirical prediction for the flow-performance relation, consider
a standard utility function of the form U = fi — 9a^. where i.i and a^ are the
expected return and variance of an investor's portfolio of mutual funds. Now
consider an additive utility function of the form U — w{fi — 9<T^) + (I — w)S,
where 0 < vv < 1 and S is an indicator function which equals 1 if the portfolio
satisfies an investor's demand for the SR attribute and 0 otherwise. Suppose that
the investor updates beliefs about the portfolio's expected return hy observing its
realized return. Changes in // affect utility at the rate of dV/dfi = w, and the
resulting change in utility may cause a reallocation of assets. For an SR investor,
vv < 1, and utility is less affected by a change in fi than for a conventional investor
for whom w — 1. If this is the case, an SR investor will have less incentive to
switch funds for a given change in // than a conventional investor, and the flow-
performance relation will be weaker in SR funds than in conventional funds.
A weaker flow-performance relation would result in lower fund flow volatil-
ity. In addition, if SR investors have multi-attribute utility functions, then one
can view investing in SR funds as consumption of the SR attribute. The asset
pricing models of habit formation predict consumption smoothing. Abel (1990),
for example, derives a model in which utility of consumption is affected by levels
of past consumption. The additive utility assumption, therefore, predicts that the
Bollen 691

volatility of fund fiow is lower in SR funds than in conventional funds, resulting

from consumption smoothing by SR investors.
A second assumption that leads to the same predictions of lower fund flow
volatility and a weaker fiow-performance relation is that at least some SR capital
is directed by a clientele with a long-term horizon. The trusts of some charita-
ble foundations or University endowments, for example, may require a certain
quantity of investment in SR vehicles.^ If this captive capital constitutes a larger
fraction of SR funds than of conventional funds, then one would expect lower fund
flow volatility and weaker flow-performance relations in SR funds. Alternatively,
institutional investors may view the SR attribute pertinent to long-term financial
competitiveness. The Enhanced Analytics Initiative,^ for example, is a consor-
tium of European institutional investors supporting sell-side research on "extra-
financial" issues, including social and environmental responsibility, defined as
"fundamentals that have the potential to impact companies' financial performance
or reputation in a material way. yet are generally not part of traditional fundamen-
tal analysis." If investors in SR funds view extra-financial issues with a long-term
horizon, then short-term variation in SR fund performance may impact fund fiow
less than variation in conventional fund performance.
Unfortunately, the Center for Research in Security Prices (CRSP) mutual
fund database, described next, does not permit direct measurement of the level
of institutional versus retail investment. Massa (2003), however, argues that fund
companies establish fee structures for each fund to appeal to the horizon of the
representative investor with larger loads and lower 12b-l fees consistent with a
longer-term horizon. Nanda, Wang, and Zheng (2005) find that when mutual
funds offer multiple share classes of a single fund, the investors who select the
share class witb lower loads have shorter investment horizons and display greater
performance sensitivity. I compare the loads and 12b-1 fees of SR and conven-
tional funds and find no substantial difference, suggesting that fund companies do
not anticipate any difference in investor horizon. For this reason, 1 do not pursue
the assumption that SR investors have a longer-term horizon.

III. Data and Summary Statistics

This section describes the data used in the study. Summary statistics of the
SR and conventional funds are presented and used to motivate some ofthe features
ofthe empirical methodology.
The primary data source is the CRSP Survivor Bias-Free U.S. Mutual Fund
Database, covering the period 1961 through 2002. A list of mutual funds clas-
sified as "socially screened" was obtained from the SIF.^ The SIF queries in-
vestment managers, institutional investors, and mutual fund companies regarding
their social screening and shareholder advocacy activities, and uses the results to
verify existing data on SR investing from Momingstar, Wiesenberger, and other
media sources. The SIF classifies mutual funds as socially screened if the man-
ager uses one or more social screens as part of a formal investment policy, or
' i thank the editor, Stephen Brown, for this suggestion.
'1 thank Todd Larsen at the SIF.
692 Journal of Financial and Quantitative Analysis

sponsors shareholder resolutions on social responsibility issues. To the extent that

tbe SIF's classification scheme establishes a low hurdle for inclusion, my results
should be biased toward the null hypothesis that attributes of the conventional and
SR funds, and their respective shareholders, are equal.
I use the SIF list to separate the CRSP funds into two groups: conventional
funds and SR funds. A total of 263 unique matches is found between the SIF
list and the CRSP funds. From these, I eliminate 58 for having an insufficient
exposure to equities, leaving 205 for analysis. 1 focus on equity funds since their
volatility and cross-sectional variation offer the richest opportunity for studying
the dynamics of fund flow. I classify a fund a.s an equity fund by tracking its year-
end allocation to equities, as listed in the CRSP database, over the fund's life. If a
fund's year-end allocation reaches 75% or higher at some point during the fund's
life, it is included in the study. This decision rule avoids inadvertently dropping
equity funds that feature temporarily reduced exposure to equities."
In the empirical analysis, I create a matched sample of SR and conventional
funds based in part on the funds' risk exposures. To estimate these, I require
monthly returns of the market index, the Fama and French (1993) size and book-
to-market factors, a momentum factor, and a risk-free security.*^ The equity series
are constructed from the CRSP equity database, and I represent the risk-free rate
by the 90-day U.S. Treasury Bill Discount from Datastream (code TBILL90).
Table I lists the number of funds, the average and median year-end total net
assets per fund, and the average and median age of the funds year by year for
equity funds in the CRSP database.'° Statistics for the years 1980 to 2002 are
reported. The explosive growth of the mutual fund industry is apparent with the
number of conventional funds increasing from 348 in 1980 to 8,009 in 2002."
The median age of the conventional mutual funds decreases with the new intro-
ductions from 15 years in 1980 to six years in 2002. The SR sample is much
smaller, reaching a maximum of 188 funds in 2001. Figure 1 depicts the growth
in the mutual fund industry. Even though the SR category is just a few percent
of the size of the overall mutual fund industry, its growth, both in terms of the
number of funds and total assets under management, generally tracks the overall
Figure 2 shows the value-weighted average retum of the conventional and
SR funds year by year. These two series are similar, though there are large differ-
ences in retums in the late 1990s. Table 2 compares the equal-weighted average

To ensure that the procedure is reasonable. I compare year by year the total net assets of equity
funds in the CRSP database, following my classification scheme, to the total net as.sets of equity funds
as reported by the Investment Company Institute (2003). In unrtported tests, the two series track each
other closely, indicating thai the procedure conforms to a standard classification of funds.
^The Fama-French and momentum factors were obtained from Ken French's Web site al
'"The CRSP database appears to have a year 2(XH) problem affecting some of its records of the year
in which a fund is founded. Over 8(K) funds are reported as being founded in years 1900. 1901. 1902,
or 1903. However, the oldest mutual fund is typically recognized as the MFS Massachusetts Investors
Trust, founded in 1924. So. for those funds with a foundation year of 19(X)-I9O3, 100 years were
added to their foundation year.
"The number of funds is larger than reported elsewhere since the CRSP has separate records for
each share class of a mutual fund. In 2002, for example, ICI reports 4.756 equity funds versus the
8,009 reported in Table 2.
Bollen 693


Summary Statistics

Usled ars the number, median and average size (in USD millions), and median and average age. Oy year, of equity mutual
funds in the CRSP database tor years 1980 through 2002 A fund is included in a given year il il has positive year-end total
net assets. A fund is considered an equity lund if the fraction of assets invested in equities reaches at least ?5% while
the luno IS in the database "SR" refers to Ihose funds identrfied as socially responsible by the Social Investment Forum.
"Conventional" refeis to ail other equity (unds.
Convent ionai SH

No. of Med. Avg Med. Avg. No. of Med, Awg, Med. Avg.
Funds Size Size Age Age Funds Size Size Age Age

1980 348 48.9 135.0 15 20.5 7 105.8 263.3 11 19.0

1981 368 45,2 120.4 16 20.4 8 64.1 248.9 11 17.8
1982 398 56.2 145.0 16 20,0 9 108.1 286.3 12 16.8
1983 440 74.1 186.7 16 19-1 9 47.3 3628 13 17,8
1984 507 64,5 172 4 16 17.6 9 60.0 401.7 14 18.8
1985 600 71 5 207.1 14 16.0 12 36.0 425.7 14 15.3
1986 723 68.6 228.7 6 14.3 14 57.4 489.8 11 14.1
1987 857 60.3 213.3 5 13.1 17 65.8 472.3 6 12.7
1988 955 49.1 206.0 5 12.7 18 54.9 499.5 6 12,9
1989 1,017 58.4 245.8 6 12.7 18 136 9 668.4 7 13.9
1990 1.155 47.4 213.7 6 12.1 23 30 7 539.8 7 12.0
1991 1.318 58.6 278.1 6 11.5 23 51.2 723.1 8 13,0
1992 1,604 53.1 290.3 6 10.1 26 65.4 769.6 7 12.5
1993 2.165 56.4 323.0 4 8.3 30 92 8 826.7 7 11-8
1994 2,865 38.9 279.7 3 7.2 51 266 494,0 3 7.9
1995 3.517 35 3 326.4 3 6,7 62 31,4 567-6 2 7,6
1996 4.249 36 d 365.7 3 6.4 77 29.6 614-4 3 7.1
1997 5.343 36.7 393.3 3 6.0 111 18.6 6432 3 6.0
1998 6.438 30.1 407.9 4 5.9 128 32.4 7384 3 61
1999 7,249 34.5 487.6 4 6,1 160 22,4 617,1 3 6.0
2000 7.971 34,7 435.2 4 6.3 184 23,1 493,6 4 6.1
2001 8,247 31.3 366.2 5 6.8 188 255 472.7 5 6,9
2002 8,009 267 299 2 6 7.6 185 201 418.4 6 78

return of the SR funds lo the average return of the conventional funds year by year
from 1990 to 2002. This period was selected due to the small number of SR mu-
tual funds prior to 1990. The table shows the difference in average returns, as well
as a significance level determined using a /-test for means. The difference is sta-
tistically significant at the 5% level in 1992. 1993. and ail years 1997-2000. with
a magnitude ranging from —7.2% in 1993 to 7.3% in 1997.^^ This result indicates
the need to control for differences in portfolio composition when comparing the
SR and conventional funds.

IV. Empirical Methodology and Results

This section describes the empirical methodology and presents the results.
Subsection A reviews the procedure used to infer fund flow. Subsection B ex-
plains the construction of a control group. Subsection C reports the estimates of
fund flow volatility. Subsection D shows the flow-performance regression analy-
sis. Subsection E discusses robustness tests.

'^This result is consistent with the findings of Bauer et al. (2005) and their "leaming" hypothesis. In
the four years prior to 1994, SR funds underperformed in half of the years, while in the subsequent time
period only one in four of the years in which there were signiticant differences favored conventional
funds. I
694 Journal of Financial and Quantitative Anaiysis

Growth in the Mutual Fund Industry

Graph A shows the total number of equity funds in the CRSP database with positive year-end total net assets, by year.
Graph B shows the total net assets of equity funds in the CRSP database with positive year-end total net assets, by year.
"SR" refers to those funds identified as socially responsible by the Social Investment Forum. "Conventional" refers to all
other equity funds.

Graph A. Nurriber of Equity Funds

10,000 - Conventional (left a»s] 200
•SR (right mis)

7,500 150

5,000 -•100


Grapti B. Total Nel Assets of Equity Funds (In USD biilior^s)

4,000 -] 100

3,000 - 75



g; s s

A. Fund Flow

Fund flow can be computed directly from a record of shareholder activity

as in Warther (1995) and Edelen (1999), but is usually inferred from changes in
a fund's total net assets and retums due to difficulty in obtaining reliable sub-
scription and redemption data. I infer fund flow several ways. Let /?,., denote the
holding period return for a mutual fund investor in fund / between times / and


where A64V,, is the fund's net asset value per share and D,,, are the distributions
received per share by the mutual fund investor during the period.'^^ Let T/M,,,
denote the total net assets of a mutual fund at time t. Fund flow can be estimated

"The tnvestmem Company Aci of 1940 permits mutual funds to distiibute realized capital gains
and income from assets held by the fund to mutual fund investors each year in order Io pass the
responsibility of paying taxes on distributions to fund shareholders.
Bollen 695

Performance of Mutual Fund Industry

Depicted Is the value-weighted average return of equity funds in the CRSP database by year. "SR" refers to those funds
identified as socially responsible by Ihe Social Investment Forum. "Conventionar refers to aii other equity funds.

Equally-WeightetJ Percentage Returns

Listed IS the equaliy-weighted percentage return ot two groups ol equity mutual tunds in the CBSP database tor years
1990 through 2002. A fund is included in a given year if it has positive year end total net assets. A fund is considered an
equity fund if the fraction of assets invested in equities reaches at least 75% while the fund is in the database, "SR" refers
to those funds identified as socialiy responsible by the Social Investment Forum. "Conventionar refers lo all other equity
funds. The p-value corresponds to a (-test for means.
Year SR Conventional Difference p-Vaiue

t990 -6.4 -6.5 0.2 0.9308

1991 27.3 28.4 -1.1 0.6026
1992 9.0 5.7 3,4 0 0411
1993 9.0 16.2 -7.2 0.0000
1994 -0.9 -2.0 1,1 0 3533
1995 22.7 220 0.7 0,6069
1996 14.0 14.8 -O.B 0.3535
1997 22.6 15.4 7.3 0.0000
1998 15.3 9.5 5.8 0.0007
1999 23.2 30.0 -6.8 0,0127
2000 -1.1 -3.7 2.7 0 0309
2O01 -10,2 -11.8 1.6 0,1233
2002 -19.8 -19.7 -0.1 0,8703

where DFij denotes dollar flow. Dollar flows in (2) are often rescaled to percent-
age flows by dividing DF,,, by TNAij-] as in Del Guercio and Tkac (2002), Sirri
and Tufano (1998), and Barber, Odean, and Zheng (2005). These calculations as-
sume all flow occurs at the end of the period. Sirri and Tufano (1998) and Zheng
(1999) also compute flows assuming they occur at the beginning of the period:


and their results are qualitatively unchanged. In my analysis, I focus on percent-

age flows, i.e., Fjj = DFij/TNAjj-1. I compute fund flows two ways, consistent
with (2) and (3), for robustness. In all cases, the results are qualitatively similar
across these two measures.
Fund companies often merge the assets of two or more funds, sometimes as a
means of eliminating poorly performing funds. Fund mergers are observationally
equivalent to subscriptions for the recipient fund, and may distort estimates of
696 Journal of Financiai and Quantitative Analysis

fund flow, fund flow volatility, and tbe flow-performance relation. To eliminate
tbe impact of mergers, I use the CRSP merger file to reduce dollar flows in the
recipient fund by the assets of tbe merged fund. Tbe assets of tbe merged fund are
taken from tbe last observation of tbe fund in the CRSP total net assets file.
Tbe CRSP database provides annual records of fund total net assets between
1961 and 1969, quarterly records between 1970 and 1991, and montbly records
tbereafter. Tbe database provides montbly fund returns tbrougbout. I use annual
observations of fund flow and performance wben studying the flow-performance
relation, and montbly observations of fund flow when computing flow volatil-
ity. Visual inspection of the data indicates a number of extreme observations of
total net assets, some of wbich are subsequently reversed, indicating possible mis-
placement of the decimal point. For this reason, I remove observations of fund
flow below - 9 0 % and above 1,000%. There are 658 such cases out of 105,355
annualobservationsof fund flow, and 463 cases out of 1.207.401 observations of
montbly flow.
Figure 3 shows tbe aggregate fund flow for conventional funds and SR funds.
Tbis figure depicts tbe growtb of tbe entire industry: dollar fund flow is aggregated
across funds, and tbis is divided by the beginning-of-year total net assets aggre-
gated across funds. There is a common component to the time-series variation in
SR and conventional fund flow. For tbis reason, the matcbing procedure described
next ensures that tbe conventional funds I select for a control group are aligned in
time with tbe SR funds.

Aggregate Fund Flow of Mutual Fund Industry
Depicted is the aggregate fund flow as a percentage of beginntng-of-year assets of equity funds in the CRSP database by
year "SR" refers to those funds Idenlified as socially responsible by the Social Investment Forum. "Conventional" refers
lo all other equity funds.

B. Control Group

In order to measure the impact of the SR attribute on the behavior of SR

investors relative to the behavior of investors in conventional funds, I need to
control for other variables that might affect estimates of fund flow volatility and
perfonnance sensitivity.
Bollen 697

1. Risk Exposures
Existing SR studies, including Luther. Matatko, and Corner (1992), Guerard
(1997), and Bauer et al. (2005), find differences in the risk exposures of SR and
conventional funds.'"* These studies focus on performance, and naturally control
for differences in risk. In my study, controlling for differences in risk is also im-
portant to ensure that any difference in investor hehavior is due to the SR attribute
rather than differences in portfolio composition.
There is some debate regarding which risk exposures affect fund flow. Gru-
ber {1996) shows that fund flow is positively related to lagged abnormal retums as
measured by both single- and multi-factor asset pricing models. Del Guercio and
Tkac (2002), however, show that Morningstar ratings subsume abnormal returns
in the flow-performance relation for mutual funds. For robustness, I measure risk
exposures using two models of returns. First, I measure exposure to market risk
by the CAPM:

where Rp is the retum of fund p, Rf is the riskless rate of retum, and RM is the
retum of a market proxy. Second, I measure exposure to market risk, as well as
the size, value, and momentum factors using the following four-factor model from

where RSMH is the retum of the size factor. RHMI. is the retum of the value factor,
and RuMD is the return of the momentum factor.
Table 3 summarizes the regression statistics estimated from the two risk
models by reporting the 25th, 50th, and 75th percentile values of the cross-section-
al distributions of the SR and conventional fund fi coefficients. I require a min-
imum of 24 months of returns when estimating the models of risk, reducing the
sample size of SR funds from 205 to 187. Panel A shows the results for the
CAPM. The median adjusted R^ is 66.52% for the conventional funds and 79.82%
for the SR funds, indicating that there are a substantial number of conventional
funds with strategies that are not fully captured by the CAPM. Note that the dis-
tributions of CAPM iS/iff are quite similar, though with medians of 0.8378 for the
conventional funds and 0.8480 for the SR funds. Pane! B shows the results for the
four-factor model. The median adjusted R^ increases to 81.58% and 87.12% for
the conventional and SR funds, respectively. The SR funds feature a significantly
smaller exposure to the size factor than the exposure of conventional funds. Since
the size factor equals the retum of small stocks minus the retum of large stocks.
''*Luther et al. (1992) document a bias toward small capitalization stocks in iheir study of U.K.
SR funds over the 1984 to 1990 period. Similarly. Guerard (1997) finds that those stocks screetied
frotn the Vantage Global Advisors universe of 1,300 stocks are cotisidcrably larger atid more value-
oriented than stocks that pass the screens from 1990 to 1994. In contrast, Bauer ct al. (2005) find that
,SR funds, both U.S. and intemational, tend to place greater weight on large slocks ihan conventional
fund.s, resulting in a .smaller exposure to the Fama and French (1993J small minus big factor than
convenlional funds.
698 Journal of Financial and Quantitative Analysis

this means that the SR funds in the sample are weighted toward larger capitaliza-
tion stocks relative to conventional funds, consistent with the results of Bauer et
al. (2005). The SR funds also have a significantly smaller exposure to momentum
stocks. Note that the interquartile ranges of the /3 coefficients of SR funds are
narrower than those of the conventional funds. The size, value, and momentum
factor coefficients have ranges of 0.4649,0.4375, and 0.1991, respectively, for the
conventional funds versus 0.3655,0.3015, and 0.1361 forthe SR funds.'^ Differ-
ences in portfolio composition in conjunction with investor demand for particular
styles could explain any difference in the fiow-performance relation of SR and
conventional funds. I control for differences in portfolio composition by match-
ing SR funds to conventional funds using the risk exposures as matching criteria.

Fund Characteristics

Lisred are values of the 25th, 50th, and 751h percentjles of Ihe crass-sectional distribution ol OLS adjusted R^ and
parameter estimates for two regressions describing the portfolio composition ot two samples of equity mutual lunds taken
from the CRSP database. "SR" refers to those funds identified as socially responsible by the Social Investment Forum.
"Conventionar refers to all olfier equity funds. Panel A shows the results tor the Capital Asset Pricing Model ffpj-f^i ( =
<*p *• ^o.Mi^M.i - ^f i) + ^i' Panel B shows the results for the four-factor model, which equals the CAPM augmerited
witfi size (SMS), vaiue (HML). and momentum {UMD) factors The regressions are estimated once for each fund with at
least 24 consecutive months of return data.
Panel A CAPM

R^ c

Conventional Funds (N = 9,189)

25tft 0.5159 -0.0045 0,6669
50th 0.6652 -0,0017 0,8378
75fh O.ai22 0,0011 1,0517
SR Funds (N= 1S7)
25th 0.6716 -0,0032 0.7146
50th 0.7982 -0.0016 0.8480
75th 0.9016 0.0000 1.0034
Difference In Means
Conv, 0.6398 -0.0016 0.8974
SR 0.7598 -0.0015 0.8737
Difference -0,1200 -0,0001 0.0237
p-value 0,0000 0,6972 0.2987
Panel B. Four-Factor Model
R2 a 0M 0UMD
Convenlior^al Funds (N = fl, 189)
25th 0,6574 -0,0053 0,7326 -0.0484 -0,1884 - 0 0494
50tti 0,8158 -0,0025 0.8763 0,1413 0,0241 0.0436
751h 0,8887 0,0000 0,9990 0.4165 0,2491 0.U97
SR Funds (N= IB7)
25tfi 0,7767 -0.0041 0.7538 -0.1287 -0.1032 -0,0565
50t(i 0,8712 -0.0017 0.8778 0,0196 0,0329 0.0176
75th 0-9306 0 0001 0,9571 0.2368 0.1983 0.0796
Difference In Means
Conv, 0,7489 -0,0025 0.8814 0,2000 0,0071 0,0312
SR 0,8368 -0,0018 0.8679 0,0972 0.0193 0.0090
Difference -0,0379 -0,0007 0.0135 0.1028 -0.0122 0,0222
p-value 0,0000 0,0383 0.3565 0,0000 0.6029 0.0795

tighter range of factor coefficients for SR funds is consistent with the argument in Geczy et
al. (2003) that SR funds offer less opportunity than conventional funds for exposure to risk factors.
This hampers the performance of portfolios of SR funds relative to the performance of portfolios of
conventional funds in their analysis as a result.
Bollen 699

2. Life Cycle
Anotber determinant of fund flow and tbe flow-performance relation tbat
may cloud inference regarding SR and conventional funds is the general life cy-
cle of mutual funds. As argued in Section II, a Bayesian investor may bave a
more diffuse prior belief regarding the expected performance of a young fund rel-
ative to tbe corresponding prior for an established fund, resulting in higher flow-
performance sensitivity. Figure 4 sbows for botb the conventional funds (Figure
4, Graph A) and SR funds (Figure 4. Grapb B) tbe 25tb, 50tb, and 75th percentile
values of tbe cross-sectional distribution of fund flow F for fund years deflned
by the age ofthe fund. In both graphs, the distribution is characterized by lower
values as funds age. Tbe median for conventional funds is approximately 25%
at age tbree, for example, and close to zero at age six. Clearly, I need to control
for age since SR and conventional funds may differ in performance sensitivity not
because of tbe SR attribute, but simply because tbe SR funds may in aggregate be
younger or older tban tbe other funds.

Fund Flow as a Function of Fund Age
Oepictecf are values of the 25th, 50th, and 75lh percentiles of the cross-secijonal distribution of fund fiow for funds
oategonzed by fund age in years, "SR" refers to those funds identified as sociafiy responsible by the Social Investment
Forum "Convenlional" refers to all other equity lunds.
Graph A. Conventional Funds

100% -
• 2591





Graph B. SR Funds







Related to age and its impact on tbe flow-performance relation is tbe size of
a mutual fund. Sirri and Tufano (1998), among others, show tbat smaller funds
700 Journal of Financial and Quantitative Analysis

tend to attract larger percentage inflows, suggesting that as funds increase in size,
the relation between flow and performance may weaken. To control for life cycle
effects, then, 1 match SR and conventional funds by age and fund size as described

3. Matching Procedure
One approach to control for variables that may explain the dynamics of
fund flow is to include additional explanatory variables in the regression analysis.
However, the assumption of linearity may be inappropriate as evidenced by the
relation between fund flow and fund age in Figure 4. An altemative approach is
to construct a matched sample of SR and conventional funds. I use two matching
procedures, corresponding to the two models of risk described above.
I apply some exclusionary criteria to observations of fund flow at the outset.
For each SR fund, only those conventional funds with first and last years in the
database that are within three years of the first and last years of the SR fund under
consideration are eligihle as candidates. This restriction ensures that the funds
will experience similar macroeconomic time-series effects. To control for age,
the conventional fund must be no more than three years younger or older than the
SR fund. In addition, only no-load conventional funds are eligible candidates for
no-load SR funds, and only conventional funds with a load are eligible for SR
funds with a load. This restriction controls for any relation between loads and the
dynamics of fund flow.
For a given SR fund, all eligible conventional funds are scored based on the
distance between the conventional fund's size and /? coefficients and the SR fund's
size and /3 coefficients. I measure the distance relating how close the SR fund (/)
is to each of the conventional funds (j) using the following algorithm:

(6) Distance^ = Y,^i/3i,t - Pj.k)/c7k)''+ {{TNAi - TNAj)/amA?,

where A' is the number of risk factors in the two models, Pk are the risk coeffi-
cients, (7k is the cross-sectional standard deviation of the risk coefficients, TNA is
the maximum size reached by the fund, and arm is the cross-sectional standard
deviation of TNA. Scaling by standard deviation normalizes the weights placed
on each matching criterion. For each annual observation of SR fund flow, fund
flows from the three conventional funds with the shortest distance to the SR fund
are added to the control group.

C. Volatility of Monthly Fund Flows

Table 4 lists summary statistics of the cross-sectional distributions of fund

flow for the SR funds and the control group. Volatility is simply the time-series
standard deviation of monthly flow using all consecutive observations for each
fund for the period 1991-2002. Recall that the CRSP records monthly obser-
vations of TNA starting in 1991. "All" sbows results when flow volatility is
computed over a fund's entire life, "Young" shows results when flow volatility
is computed for fund age five years or less, and "Mature" shows results when
Bollen 701

flow volatility is computed for fund age six years or greater. A volatility estimate
must contain at least 12 observations to be included in the analysis.

Monthly Fund Flow Volatility Comparisons

Usled are values of Ihe 25!h, 50th, and 75lh percentiles of the cross-sectional distnbution of monlhly volatility of percentage
fund flows for Iwo samples of equity mutual funds taken from the CRSP database "Air shows results when flow volatility
is cornputed over a (und's entire life, "Young" shows results when flow volatility is computed for fund age five years or less,
and 'MaturB' shows results when flow volatility is computed for fund age six years or greater, Aiso shown are the averages
and two-sided p-value of f-tests for a significant difference. "SR" refers to those funds identified as socially responsible
by the Social Investrnent Forum. "Matched" refers to a subset of ail other equity funds, and consists of three conventional
funds for each SR fund matched on size, age, start date, and the 3 coefficients from the four-factor modei To be included
in the analysis, a volatility estimate must contain at least 12 consecutive months of flow data.
All Funds Young Funds Mature Funds

Matched SR Matched SR Matched SR

25th 0.0555 0.0462 0,0634 0,0502 0.0226 0.0182

50th 0.0955 0.0772 0,1052 0.0854 0.0355 0.0268
75th 0.1492 0.1261 0,1649 0.1440 0,0754 0,0519
No, o( obs. 456 152 429 143 210 70
Avg. 0.1455 0.1174 0.1654 0.1343 0 0669 0,0399
p-value 0,0645 0.0869 0,0030

Using all observations to estimate volatility, the 25th, 50th, and 75th per-
centile values of the SR funds are all lower than the conventional funds. 7.72%
versus 9.55% at the median, for example. The interpretationis that a $100 million
fund experiences monthly flows with standard deviation of about $8 million for
the SR funds and $10 million for the conventional funds. The sample means are
higher than the medians. 11.74% for the SR funds versus 14.55% for the conven-
tional funds, significantly different at the 10% level using a /-test for means. These
findings indicate that SR fund flow is economically and statistically significantly
less variable than that of conventional funds.
As mentioned in the prior subsection. Chevalier and Ellison (1997) and
Sirri and Tufano (1998) both document life cycle effects in mutual fund flows.
Younger funds feature stronger flow-performance relations and larger percentage
fund flows than more mature funds. Consistent with the life cycle evidence. Table
4 shows for both SR and conventional funds, flow volatility for Mature funds is
less than half the volatility of Young funds. Note also, however, that for both the
Young and Mature subgroups, the SR funds have statistically significantly lower
flow volatility than their conventional counterparts.
My analysis of monthly flow volatility suggests thatSR investors move money
in and out of their mutual funds at a significantly slower rate than investors in other
funds. Furthermore the difference persists as funds age. Lower flow volatility may
represent consumption smoothing on the part of SR investors. These results are
inconsistent with Hypothesis 1 as well as the assumption of rational leaming with
diffuse prior beliefs. The results are consistent with the assumption of a multi-
attribute utility function, however, which motivates Hypothesis 2 when the SR
attribute is valued conditional on performance or motivates Hypothesis 3 when
the SR attribute is valued unconditionally. In the next subsection, I investigate the
flow-performance relation in SR funds to make the inference more precise.
702 Journal of Finanoial and Quantitative Analysis

D. Flow-Performance Relation

Analysis of the flow-performance relation requires specifying a response

function; in particular, I need to specify how many lags of performance to include.
This choice specifies the horizon over which investors measure performance. In
order to avoid misspecifying the response function, I estimate the relation be-
tween annual fund flow and performance lagged one year. This can be viewed
as the aggregate response over the course of a year to a fund's prior year perfor-
I estimate OLS parameters of the following flow-performance regression:

(7) F,v - a

where F,,, is the fund flow of fund / in year t, Sj = I if fund / is an SR fund and
0 otherwise, //,_, — 1 if fund i is conventional and has a positive lagged return
and 0 otherwise, If|_^ = 1 if fund / is SR and has a positive lagged return and
0 otherwise, /,^,_, = 1 if fund i is conventional and has a negative lagged return
and 0 otherwise, lf,_j — 1 if fund / is SR and has a negative lagged return and
0 otherwise, and Rij-\ is the lagged return. I frame the asymmetry around a 0
return for two reasons. First, a 0 return seems to be a reasonable quantitative
anchor that might affect inve.stor decision making. Second, coefficients in the
flow-performance relation are easy to interpret in terms of inflows and outflows
of investor capital. A positive coefficient on positive returns corresponds to a cash
inflow, whereas a positive coefficient on negative returns corresponds to a cash
outflow. Given the construction of the indicator variables, coefficients measure
sensitivity of fund flow to lagged returns for the following subsets:

(8) 00 conventional funds following positive returns,

P\ SR funds following positive returns,
02 conventional funds following negative returns, and
0^ SR funds following negative returns.

To be included in the regression analysis, an observation of fund flow must be

from a fund with at least $ 10,000,000 of total net assets in the two successive
years used to compute the flow, consistent with the procedure in Chevalier and
Ellison (1997). This eliminates extremely small funds that may exhibit explosive
growth and distort the results. I also discard observations of fund flow prior to
1980 since the number of funds in the pre-1980 time period is quite small. The
results are robust to changes in this cutoff.
Table 5 lists tbe OLS parameter estimates. For the funds matched using the
CAPM as listed in Panel A, cash inflows to conventional funds increase 0.6529%
for every 1% increase in prior year return when the lagged return is positive.'^ In
contrast, cash inflows toSR funds increase 1.4587% for every 1% increase in prior
""Gruber (1996) finds that fund flow is also related to performance lagged two years. I only in-
clude performance lagged one year to focus attention on the information provided by the most recent
observation in the context of Bayesian updating.
^^De\ Guercio and Tkac (2002), for comparison, include lagged raw and abnormal returns simul-
taneously as independent variables and estimate coefficients of 0.45 and 3.24, respectively.
Bollen 703

year return when the lagged retum is positive. This result shows that investors in
SR funds are more sensitive to positive retums than conventional investors. The
heightened sensitivity to positive retums is consistent with both assumptions mo-
tivating Hypothesis 2, rational leaming with diffuse priors and a conditional util-
ity function, but inconsistent with the assumption of an additive utility function
underlying Hypothesis 3. As discussed in the prior subsection, 1 can rule out ratio-
nal leaming with diffuse priors due to the lower fund flow volatility of SR funds,
hence, the conditional utility function seems to capture the salient features of tbe
data the best. Now consider the sensitivity to performance following negative
retums. Cash outflows from conventional funds increase by 0.5360% for every
1% decrease in prior year retum when lagged returns are negative. SR outflows
increase by just 0.3207% for every I % decrease in prior year return when lagged
retums are negative. Furthermore, the coefficient on negative lagged retums is not
statistically different from zero for SR funds. This result indicates that investors
in SR funds are less sensitive to negative returns than conventional investors.

OLS Regression Results

Listed are OLS parameter estimates of the 3 coeffjcientsol the following regression:

where F is fund flow as a perceniage of beginning-ol-year total nel assets, S, = 1 it fund/is SH and 0 otherwise,/',_, = 1
If fund / is conventional and has a positive lagged return and 0 otherwise, / f , _ , = 1 il lund i is SR and has a positive
lagged return and 0 otherwise, /f,_ , = t if tund i is conventional and has'a negative lagged return and 0 otherwise,
1^(_i = 1 if 'und / is SR and has'a negative lagged return and 0 otherwise, and fl is return. "SR" relers to those funds
identified as socially responsible by the Social investment Foruin. "Afl" shows results when obsetvations are inciuded
from a tund's entire life, "Young" shows results when only observations Icr fund age five years or less are included, and
"Mature" shows results when only observations for fund age si;< years or greater are included, Panei A shows results when
each annual observation ot an SR tund is matched to annual observations ot three conventionai funds where the match is
based on age, start date, size, and CAPM 0. Panel B shows the resuits wtien the match is based on age, start date, size,
and the four g coefficients from the four-factor model.

PanelA. CAPM Match

Aii Funds Young Funds Mature Funds
(N = 2,696) (N = 912) (N= 1,784)

(-Stat. p-Vaiue (-Stat, p-Value f-Stat, p-Value

R3 0.0579 0,0434 0,0723

0Q 0,6529 6.4302 0,0000 0,6887 3,2610 0,0012 0,5666 5,4872 0,0000
01 1.4587 8 0376 0,0000 1,8922 3.6405 0,0003 1,2577 7,7575 0,0000
02 0,5360 2,4420 0,0147 0,3543 0,7484 0,4544 06673 3,0667 0,0022
03 0,3207 0,7212 0.4709 0,3807 0,3239 0,7461 02019 O4946 0,6209
Panel B Four-Fig dor
1 Match
Aii Funds Young Funds Mature Funds
(N = 2,836) (N = 952) (N= 1,884)

(Stat, p-Value f-Stat p-Value l-Stat. p-Vaiue

R' 0,0572 0,05B3 0,0609

0Q 0,7102 7,1396 0,0000 1,1778 4,7588 0,0000 0,4751 5 1368 0.0000
0\ 1,4186 7,9447 0,0000 1,8149 3,5770 0,0004 1,2382 7,7734 0,0000
8? 0,4894 2.2161 0,0268 0,3788 0,7173 0.4734 0,5194 2,4907 0,0128
0,3117 0,7084 0.4788 0.4353 0.3773 0 7060 0,2027 0,5020 0,6157

The asymmetric difference between SR funds and conventional funds Is not

consistent with any of the three hypotheses discussed in Section II. All of the mo-
tivating assumptions predict a symmetric difference: either the flow-performance
704 Journal of Financial and Quantitative Anaiysis

relation would be stronger or weaker in SR funds than conventional funds for both
positive and negative perfonnance. Prior research has documented similar asym-
metries. As mentioned in Section II, a standard result in the flow-performance
literature is that poor performers are not punished with outflows to the same ex-
tent that superior performers are rewarded with inflows. Kahneman and Tversky's
(1979) prospect theory provides one explanation for the asymmetric response to
performance by assuming that investor attitudes are described as risk seeking in
the region of losses and risk averse in the region of gains. Alternatively, Lynch
and Musto (2003) argue that investors may expect diat management companies
will replace managers of poorly performing funds, and may anticipate expected
returns to increase as a result.
As listed in Table 5, three results stand out when observations are split by
fund age. First, for both young funds and mature funds, the sensitivity of SR fund
flow to positive lagged returns is still approximately twice that of conventional
fund flow. Tbis supports the assumption of a conditional utility function because
a utility-based explanation predicts differences between SR funds and their con-
ventional counterparts persist over time. Second, for mature funds, the sensitivity
of SR fund flow to negative lagged returns is insignificantly different from zero,
whereas the sensitivity of conventional fund flow to negative lagged returns is
a statistically significant 0.6673. Both these results are consistent with tbe full
sample. Third, for young funds, tbe sensitivities of SR and conventional funds
to lagged negative returns are similar in magnitude and neither is significantly
different from zero.
Panel B lists results for the four-factor match. In all cases, the coefficients'
magnitudes and significance levels are consistent witb the CAPM matcb. This re-
sult indicates tbat the differences between SR funds and tbeir conventional coun-
terparts cannot be explained by any differences in risk exposure.

E. Robustness Tests

In unreported analysis, I renan tbe flow-performance tests on subsets of tbe

data split two ways. First, to determine wbetber SR investors in aggregate have
changed bebavior over time, I split tbe observations into an early period from
1980 to 1993 and a later period from 1994 to 2002. In both periods, coefficients
on lagged positive returns are statistically significant, and the sensitivity of SR
fund flow to lagged positive returns is approximately double tbat of conventional
funds. For the 1980 to 1993 period, tbe sensitivity of fund flow to lagged nega-
tive returns is not statistically significant for either group of funds. For tbe 1994
to 2002 period, the sensitivity of fund flow to lagged negative returns is substan-
tially smaller for SR funds than conventional funds. In sum, tbe resuits across tbe
subsets indicate tbat preferences of SR investors are persistent and do not indicate
tbat behavior is explained by a model of rational learning.
Second, to determine wbetber SR investors distinguish between types of SR
funds as measured by the extent of their screening activity, I collect informa-
tion from mutual fund company Web sites regarding tbe number and types of
SR screens employed. I construct two subsets, one for funds that exclude only
"sin" companies sucb as tobacco or alcohol producers, and tbe otber for funds
Bollen 705

with multiple concems. The coefficient estimates are qualitatively robust across
the subsets, suggesting that investors behave similarly regardless of the extent of
portfolio screening. These results should be interpreted with caution, however,
because the limited size of the subsamples likely reduces the statistical power of
the test.
As noted earlier, the CRSP data contain a number of extreme observations
of fund total net assets. Even after excluding observations of fund flow below
—90% or above 1,000%, analysis of the regression residuals suggests the pres-
ence of outliers that might be influencing the results. Botb the Jarque-Bera and
Koimogorov-Smimov tests for normality reject the null hypothesis that the resid-
uals are Gaussian, primarily due to excess kurtosis. To ensure that the conclusions
are robust to the presence of outliers, I reestimate the coefficients of the regres-
sions in (7) by minimizing the sum of absolute errors, rather than the sum of
squared errors. The LAD regression places less weight on outliers. I use tbe
IMSL routine DRLAV to estimate parameters. As described in Birkes and Dodge
(1993), standard errors of tbe estimates are approximately equal to OLS standard
errors scaled by T/CTOLS. where ITOLS is the standard deviation of residuals from
OLS and


where A^ is the number of observations, e are residuals from the LAD regression
sorted in ascending order, and fc|.2 are the two integers closest to [N - l)/2 ±
\J[N — 2). Table 6 shows the results. In almost all cases, the coefficients are
smaller, which is consistent with the procedure putting less weight on the tails,
but the qualitative inference is the same as in the OLS analysis.
An analysis of the demographic characteristics of SR investors, and a com-
parison to the demographics of investors in conventional funds, may provide ad-
ditional insight regarding the behavior of SR investors. While 1 am unaware of
any published research concerning the demographics of SR investors, private con-
versations with the research staffs at two large SR fund companies revealed that
SR mutual fund investors are significantly more likely to be female, higbly edu-
cated, and have lower income than investors in conventional funds. To the extent
that one expects educated female investors to be less prone to an overconfidence
bias than other investors (see Barber and Odean (2001)), one may expect them
to trade less, tbereby generating lower fund flow volatility. Unfortunately, invest-
ment companies are reluctant to reveal information regarding their shareholders,
so I am unable to generate and test empirically more detailed bypotheses regard-
ing investor behavior. However, even with the observable aggregate flow data,
significant differences between SR and conventional investors are apparent.

V. Conclusions
This paper analyzes the dynamics of investor fund flows in a sample of so-
cially screened equity mutual funds. SR funds feature significantly lower monthly
fund flow volatility than conventional funds. This result suggests that the extra-
706 Journal of Financial and Quantitative Anaiysis

LAD Regression Results

Listed are LAD parameter estimates of the 0 coefticienis ot ihe following regression:

where F :s fund flow as a percentage of beginning-of-year total net assets, S, = l i f fund / is SR a i d 0 otherwise, /,•,_, = 1
if fund / is conventional and has a positive lagged 'eturn and 0 otherwise, if,_, = 1 if fund / is SR and has a'positive
lagged return and 0 otherwise. ^ r - T ~ ^ '^ '^'"-' ' '^ conventionai and has a negative lagged return and 0 otherwise,
'f,(_i = ' 1' 'fJ^C ' isSR and has a negative lagged return and 0 othen/jise. and fl is return, "SR" refers to those funds
identified as socially responsible by the Social Investment Forum "Aii" shows results when observations are inciuded
Irom a fund's entire life, "Young" shows results when only observations for fund age five years or less are included, and
"Mature" shows results when only observations for fund age six years or greater are included. Panel A shows results when
each annual observation ot an SR fund is matched to annuai observations cl three conventional funds where the match is
based on age, start date, size, and CAPM 0. Panel B shows the results when the match is based on age. starl date, size.
and the four 0 coeff Jcients from the four-faotor r
PanelA. CAPM Match
All Funds Young Funds filature Funds
(N = 2,696) 1N = 912) 1N= 1,784)

/-Stat, p-Value t-Stat, p-Value (-Stat p-Value

^0 0.3355 10,7113 0,0000 0,3852 4,2745 0,0000 0,2884 6.2440 0,0000

3, 0,8654 15,4567 0,0000 1,1117 5,0120 0,0000 0 6431 8,8685 0 0000
02 0 4451 6,5720 0.0000 0.4694 2,3238 0,0204 0,5253 5,3976 0,0000
02 0,2053 1,4967 0,1346 0,4023 0 8024 0,4226 0.3062 1,6774 0,0936

PanelB. Four-Factor Match

All Funds Young Funds Mature Funds
(N = 2,836) (N = 952) (N= 1,884)

l-Stat, p-Vaiue (Stat, p-Vaiue /-Stat, p-Vaiue

00 0,4122 10,8687 0,0000 0,6815 6,4689 0,0000 0,2780 9,3042 O.OOOO

0, 0.8547 12,5553 0,0000 1,0942 5,0658 0,0000 0,6247 12,1414 0,0000
02 0,3485 4,1394 0 0000 0.3402 1 5134 0,1305 0.3875 5,7517 0,0000
^3 0,1797 1 0710 0,2842 0,4401 0,8962 0.3704 0,3269 2,5066 0,0123

financial SR attribute serves to dampen the rate at which SR investors trade mutual
I also compare the relation between annual fund fiows and lagged perfor-
mance in SR funds to the same relation in a matched sample of conventional
funds. For the 1980 through 2002 period, SR investors exhibit a significantly
larger response to positive returns than investors in conventional funds, but a
smaller response to negative returns than investors in conventional funds. Fur-
thermore, the differences between SR funds and their conventional counterparts
are robust over time and persist as funds age. Taken together, the evidence sug-
gests that preferences of SR investors can be represented by a conditional multi-
attribute utility function in the sense that they appear to derive utility from being
exposed to the SR attribute, especially when SR funds deliver positive returns.
Mutual fund companies, which continually compete to offer new funds in an
effort to attract investor capital, can expect SR investors to be more loyal than in-
vestors in ordinary funds. My results should extend to other sectors of the mutual
fund industry characterized by specific extra-financial attributes—I leave tests of
generality to future research.
Bollen 707


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